Understanding Company Accounts and Reports - International Financial Reporting Standards - Essay Example

Understanding company accounts and reports Introduction IFRS, which is the International Financial Reporting Standards, is a body of standards issued by the International Accounting Standards Board (IASB). IASB adopted conceptual framework for financial reporting, which replaced the framework for preparation and presentation for financial statements (1989). The conceptual framework therefore is an updated framework that contains the objectives of financial reporting and qualitative characteristics of useful financial information (Shamrock 2012). Conceptual framework is formed under the IFRS and contains principles and concepts that govern the preparation of financial information and financial reports. IFRS was formerly referred to as International Accounting Standards Committee Foundation. IFRS is now used for the new standards and it recognises the need for disclosure in the financial statements. Generally Accepted Accounting Principles (GAAP) is the framework of accounting standards, rules and procedures (Robinson 2012). Conceptual framework for financial reporting It is true that the conceptual framework for financial reporting sets desirable characteristics of financial reports. Several reasons are in support of this the first being that the conceptual framework brings out the usefulness, objective and limitations of general purpose financial reporting. The objective being to provide information concerning the financial position of the organisation to both potential and existing investors, and lenders to help them make decisions on whether they should invest into the company depending on the returns that they expect to get from their investment. The lenders as well are able to determine the company’s ability of paying the outstanding loans and due interest and can make decisions on whether or not to offer lending to the company by assessing its prospective future inflows (Shamrock 2012).General purpose financial information is therefore mainly directed for investors and the lenders since they are the primary users of this information. They enable the investors and lenders to estimate the value of the company. Due to the varying needs of the users of financial information, the conceptual framework ensures that the financial reports are prepared in a way that they meet the needs of a large number of primary users. The preparation of financial information is therefore based on estimated values whose basis of estimation is based on concepts established by the conceptual framework (IFRS2013). Conceptual framework also facilitates the reporting of an entity’s economic resources, its claims as well as their respective changes by the general purpose financial reports. Information concerning economic resources and claims enable users to determine the strengths and weaknesses of the entity, which then help in predicting its liquidity and solvency and to determine how easily it can obtain financing and concerning its priorities in using the future cash flows for settling obligations. The different economic resources therefore have different effects on the future cash flows of the entity and thus there is a need for users of financial information to know the nature of the available resources. The changes in the economic resources and claims of the entity results from its financial performance and other transactions such as debt issuing and therefore users of the financial information need to distinguish these changes in order to determine the future cash flow. An entity’s financial information helps users to determine its returns which explain the effectiveness of the management in using the entity’s resources. The past financial information may also be used by the users in predicting the future returns on the economic resources (IFRS 2013). Conceptual framework also sets desirable characteristics of financial reporting from the basis of accrual accounting which brings out the effects of events and transactions on claims and economic resources of an entity in the period that they occur even in cases where the respective receipt of cash happens in different period. This provides a better basis for predicting the future performance of the entity than when the reports are prepared barely on the receipt and payment of cash during the period. The reporting on the period’sinformation concerning the changes in the entity’s economic resources and claims helps to determine the ability of the entity to generate cash inflows in the past and future. This helps to determine how much the entity can utilize the available resources to generate additional cash rather than just using the resources from investors and lenders. Of importance in determining the ability of the company to generate cash flows also is factors such as rates of interest and market prices. Financial information shown by the past cash flows of an entity may also be used in determining the future cash flows and overall future performance of the entity by evaluating its investing and financing activities thus determining its solvency or liquidity. It also helps in the determination of changes in claims and economic resources of an entity that do not result to financial performance. It is therefore important to determine the effects of these changes on the future financial performance (IFRS 2013). The conceptual framework also gives the qualitative characteristics of useful financial information. Conceptual framework has an economic phenomenon which explains the changes in the economic resources and claims of the entity. It reflects cost as being the restriction to providing useful financial information. The qualitative characteristics of useful financial information explained by conceptual framework are faithful representation, relevance, timeliness, understandability, variability and comparability. Relevance applies in that relevant financial information has the ability of changing the decisions made by the users of financial information. Relevance is brought about by value, either confirmatory or predictive. Predictive values usually have a confirmatory value which are actually determined when the true values are attained. The characteristic of faithful representation is based on the representation of financial reports by words and numerical representation of the economic phenomena. Useful financial information therefore must faithfully represent the phenomenon which it supports and this call for it being free from errors, neutral and complete. Completeness means that all the relevant information to enhance the user’s understanding is available, while neutrality implies that the selection of the information is unbiased, and not manipulated. Being free from errors means that there are no omissions or errors made when describing the phenomena and in the process of producing the financial reports. For instance giving an explanation to the use of an estimated value and making faithful explanation concerning the nature of the process used to estimate. Relevant information should not be unfaithfully represented, neither should irrelevant information be faithfully represented (IFRS 2013). Materiality as another qualitative characteristic is explained in the basis that financial information is material if its omission or misrepresentation in the financial reports influences the decision of the users of the financial information. Comparability as another characteristic implies that useful financial information from different accounting periods should be easy to compare for the users of financial information to determine the similarities or differences between the periods and the items. Consistency is helpful in determining comparability and there is a likelihood of attaining comparability of relevant and faithfully represented information. Verifiability is explained in that if financial information is verifiable, it is possible for different independent users to arrive at the same conclusion using such same information. This may be done through direct observation or indirectly. It is also possible to verify the explanations concerning the financial information. Timeliness as another characteristic means that financial information is useful if it is available to decision makers on time to enable them to make decision. Understandability is explained in that understandable information is one that is classified and represented concisely and clearly. Users of the financial information might therefore need an explanation in understanding the complex phenomena used in the financial reports. Conceptual framework also brings out the aspect of cost as being a constraining characteristic to the preparation of financial information. The preparation of financial information and reports involves the company incurring some costs. The cost aspect however is argued out by the benefits that are achieved by providing the information to the users. These costs involved include the reduction in returns for investors and other users of financial information in order to pay the providers of the financial information. There also costs involved when analysingand interpreting the financial information. There is also a cost that is involved in developing a financial reporting standard whereby the board has to consult various parties such as auditors and providers and users of the financial information. The benefits on the other hand that outweigh the costs are that presentation of faithfully represented information helps the users to make confident and informed decisions. This further benefits the whole economy in the form of reduced cost of capital as a result of efficient functioning of the capital markets. It is therefore evident that the conceptual framework sets out characteristics of financial reports that are desirable (IFRS 2013). Reasons for differences in qualitative characteristics of financial reports in GAAPs in china and those in the IFRS conceptual framework The differences between the qualitative characteristics of GAAPs in china and the conceptual framework in IFRS start with the difference in comparability whereby china GAAPs which is rule based has a greater comparability of accounting numbers in china GAAPs than in the conceptual framework of IFRS which is principles based and comparability is observed to decrease following the adoption of IFRS. Another difference which concerns the two is the characteristic of relevance with that in the IFRS conceptual being more relevant on the basis of value, which gives it the ability of being able to provide more information in terms of future cash flows and being less prone to frauds like the china GAAPs. There is also a difference in the accruals characteristic with it being more common in the conceptual framework than it is in the china GAAPs which means that the quality of reporting is more advanced and more efficient in the IFRS conceptual framework than in the China GAAPs. The difference result to china GAAPs not reflecting the true value of companies’ position and thus leading to presentation of untrue financial information to investors. The differences in the qualitative characteristics of financial reports as brought out in the China GAAPs and those brought out in the conceptual framework is brought about by the fact that the conceptual framework of IFRS is rules principle based while the China GAAPs is rules based thus the difference in the characteristics. The difference is also as a result of the fact that the IFRS is more consistent on the observance of the accounting concepts and principles which the China GAAPs does not observe (Hong2008). Significance of reporting difference with respect to IFRS, China regulators and Chinese companies There is a significant difference that is realized in preparation of financial statements using IFRS and using China GAAPs. The effects from these differences are also significant with the china GAAPs failing to reflect the true financial position and failing to deliver the right information concerning the financial information of the companies to the users of the information. The reporting difference as lead to a compromised quality of the accounting of the financial reports produced using the China regulators as opposed to the good quality obtained from reporting using the IFRS. The concentration of form over substance in preparation of financial reports lead to production of untrue reports thus lowering the quality of the financial reports produced under China regulators and leading to misrepresentation of the true companies values (Hong 2008).There has also been misrepresentation of the true value in accounting for leases using the rule based accounting system with the classification into operating and capital leases that lead to recording of information using the form rather than substance. China GAAPS also lower the quality of accounting quality of the Chinese companies by noncompliance to the IFRS recognizable accounting. The difference also results to the users of financial information in the Chinese companies not being able to have the right information to help them in determination of past and present and in prediction of the future cash flows, this further leading to making of poor investment decisions. The difference between the IFRS reporting and the Chinese regulation reporting has also resulted to a lower variance to change in the net income, a lower ratio of change in cash flow as well as a negative correlation between cash flows and accruals in the companies that are owned by the state (Hong 2008). There is another difference between the IFRS reporting and the reporting by the China regulators concerning the relevance characteristic. Nom compliance with the characteristic by the china regulator has led to the Chinese companies reporting financial information that is less relevant in terms of value thereby leading to inability of determining the true cash flows of the companies. The reporting of financial information using the china regulators has also resulted to increased levels of financial frauds and misappropriation of funds by management in the Chinese companies. This is as a result of managers’ claim to observe the accounting rules preventing the ability of auditors to prevent such scandals. There is also the difference between the Chinese accounting system and IFRS in that the reporting system in the Chinese system is more rigid thus fails to consider the dynamic accounting treatments for various transactions and events. This further leads to production of misleading reports that compromise the decisions made by the users of the financial information. The difference also between the IFRS reporting and China regulators reporting has resulted to inaccurate determination of the true market values of the financial items of the Chinese company. The difference therefore has resulted to a widened gap between the IFRS reporting and reporting by the china regulators with the IFRS reporting leading to high and good quality of the financial reports, that reflect true value of the entities and enabling the users of the financial information to make right and confident decisions using true information of the company whereas reporting by the china regulators has resulted to reporting of low and poor quality financial reports which have led to compromised performance of companies and to wrong decisions by the users of financial information. The likely response by china towards existing and future pronouncements of IFRS The likely response by China towards the present and future pronouncements of IFRS is a negative response. This is evidenced by the fact that China has never agreed to the full implementation of IFRS. It has over time been exploiting the debates that aim at confronting its current accounting systems and have not been in support of the IFRS. China is also likely to respond negatively to the issue of IFRS compliance to substance over form as opposed to its observance of form over substance. It is also likely to respond negatively to the requirement of IFRS’ proposed draft concerning accounting for leases which involve classification of leases to class A and class B as opposed to its classification into finance and operating leases and using form over substance to account for them. China is also likely to respond negatively to the accrual concept in the IFRS conceptual framework. China regulators do not enhance observance of the accrual basis of accounting and thus will likely show resistance in its adoption. China will also be likely to respond negatively to the flexibility of the IFRS and will be likely to prefer using the rigid rules that its companies have used over time. China is likely to reject the flexibility of IFRS as it keeps making amendments and changes to its accounting principles and standards as opposed to the unchanging rules used in china’s system of accounting. China is also likely to respond negatively to the over emphasis on relevance and reliability that is insisted by IFRS conceptual framework.The conceptual framework of IFRS emphasises on the relevance of financial information which depends on value. There is also a likelihood of there being a negative response by china toward the pronouncements of IFRS due to the fear of adopting the many and complex standards under IFRS as opposed to its simple standard rules governing the accounting system (Hong 2008). Conclusion In conclusion, the foundation of IFRS conceptual framework is laid on the objective of general purpose financial information. Conceptual framework describes the concepts and principles that govern the preparation of financial information and reports. It also gives the qualitative characteristics of useful financial information and reports. China GAAPs on the other hand are the guidelines that govern the accounting and preparation of financial information and reports in china. The comparison of the china GAAPs and IFRS arrives to the conclusion that china GAAPs are rule based while the IFRS are principle based. IFRS has also been considered to produce high quality financial reports and thus more reliable for the users’ of the financial information. China GAAPs have been considered to offer a low quality of accounting information. Reference list IFRS. (2013). A Review of the Conceptual Framework for Financial Reporting. Retrieved from: http://www.ifrs.org/current-projects/iasb-projects/conceptual-framework/discussion-paperjuly2013/documents/discussion-paper-conceptual-framework-july-2013.pdf. Hong, Y. (2008). Do Principles-based Accounting Standards Matter? Evidence from the Adoption of IFRS in China. Shamrock, S. E. (2012). IFRS and US GAAP: A comprehensive comparison. Hoboken, N.J: John Wiley. Robinson, T. R. (2012). International financial statement analysis. Hoboken, N.J: John Wiley & Sons. Read More